Retail outlook 2025: High demand spurs retailer flexibility amid shrinking supply

• What Retailers are displaying increasing flexibility in terms of store format size and lease structure
• Why They are adapting to extremely limited new supply hitting the market
• What next Compressing cap rates and pending tariff threats from the U.S. may significantly affect retail market performance next year

Deals and leasing activity may be muted in Canada’s retail market, but the year didn’t go by without some noteworthy activity.

Cadillac Fairview sold two malls to Westcliff Group for a combined $334m, Shake Shack leased its first three Canadian locations, Jadco picked up a Montréal-area shopping centre for $126m and many sub-$40m retail properties changed hands all across the country.

All of these deals took place against a backdrop of tightening supply-and-demand conditions, rising rents and an increased preference for established essential retailers.

Looking into next year, Green Street News spoke with Oliver Harrison, senior vice president of leasing and tenant experience at RioCan; Brandon Gorman, executive vice president of JLL’s agency retail group; and Alex Edmison, senior vice president of CBRE’s urban retail team, to learn what they’re anticipating for the retail market in 2025.

Increasing flexibility

One theme highlighted by the experts is that retailers are becoming more flexible amid increasingly tight supply-and-demand conditions.

“Flexibility can be taking smaller store formats, it can be doing stores on multiple levels, you name it,” Edmison said.

Harrison pointed to the September opening of a No Frills grocery store in an 8,000 sq ft space at RioCan Hall in downtown Toronto as a prime example of how retailers are adapting their footprints to current market conditions.

“Two years ago, you’re not putting a No Frills into an 8,000 sq ft space,” Harrison said. “Not only did they have the foresight to realize that they can make that work and redesign their store, it’s been phenomenally successful.”

Loblaw Cos. has opened a number of smaller-format No Frills stores in urban centres. In May, another No Frills opened at Toronto’s King Street West and Shaw Street in a 10,000 sq ft space in the podium of a condominium building. It’s roughly a third of the size of an average No Frills.

“They see the opportunity to access consumers, but they can’t just expect to roll in with a 40,000 sq ft format because that space physically does not exist and is unlikely to exist at scale anytime soon, if ever,” Edmison said. “So, they adapt and they develop a model that can work in 10,000 sq ft feet. It’s not so easy to do. It takes a lot of work for a retailer to be that flexible with their business.”

Similarly, RioCan saw the opening of Sephora’s smallest store in Canada earlier this year at its downtown Toronto development The Well.

“That store, which is only 3,500 sq ft, from a productivity perspective, it is outperforming our store at Yonge and Eglinton, which is two-and-a-half times the size,” Harrison said.

With the ability to succeed in smaller spaces being actively proved, and large-format storefronts in extremely short supply, demand for smaller spaces is up.

“We are seeing a lot of demand from small-format retailers, think sub-2,500 sq ft, specifically health and wellness, professional services, medical, dental, food and beverage – those are the most active categories,” Gorman said. “Particularly in dense locations where there’s either existing or planned intensification and close to public transit.”

Retailers have also become more flexible when it comes to lease structures, Harrison said. The typical 15-year lease with two rent step-ups built in that are five years apart is now making way for leases with annual rent bumps. This better allows lessors to keep rent prices in line with inflation, he noted.

Cap-rate compression is coming

Not only is capitalization-rate compression anticipated in 2025, it’s already here, with Gorman saying that they’ve observed some shrinkage over the past three months.

“There’s still a bit of a disconnect between pre-Covid pricing and today’s pricing,” Gorman said. “A lot of owners still think they’re sitting on 3.5% and 4% caps, which we saw pre-Covid, but not since. I expect throughout Q1 and Q2 of ’25, we’ll continue to see cap rate compression – not to pre-Covid levels but we are going to see cap-rate compression from where it is today.”

In the urban retail assets that he deals with, Edmison has similarly seen cap rates begin to compress.

“Cap rates are compressing absolutely, 100%,” Edmison said. “The capital is there to buy assets, the fundamentals are strong – they’re stronger than other asset classes. Interest rates coming down has a fairly significant impact because it means you can’t get risk-free returns at X, so that capital then cycles into real estate. And the more capital there is, cap rates compress. So we have seen them come down, particularly in the latter half of this year, and it’s interest rates really driving it.”

Bracing for tariffs?

U.S. President-elect Donald Trump’s pending threat of a 25% tariff on all U.S. imports has left a certain level of uncertainty around American retailers’ desire to operate north of the border, and subsequent uncertainty around the retail spaces they occupy.

“Until we see if and what those [tariffs] are, it’s really hard to lay a forecast,” Edmison said. “But you could see that would potentially favor domestically produced retail goods versus things you would order from the United States.”

Harrison says RioCan is still “extremely bullish on the prospects for quality retail space” heading into 2025, but that the tariffs may cause retailers to take a harder look at their Canadian operations.

“That would be the only thing I would say from a risk perspective that I would highlight, and it is relatively small versus how much positive momentum and how strong I think 2025 is going to be for us,” he said.

Edmison agreed that an extreme economic depression scenario seems unlikely, but 2025 probably won’t be a banner year either.

“I think it’s probably going to be somewhere in the middle,” he said. “If we see [tariffs] triggering inflation, obviously that would have impacts, but we just don’t know what’s going to happen, right? We have to see what we’re in for.”

Essentials-anchored retail is still king

Coming out of the pandemic, retail properties anchored by essential retailers like grocery stores or pharmacies reigned supreme. That preference is only continuing to grow as consumer spending slows and economic uncertainty lingers.

“Leasing to these essential retailers provides safeguards against economic downturn, given they offer necessary goods and services to consumers who will prioritize that regardless of their financial constraints,” Harrison said.

Gorman highlighted a recently closed deal for a Loblaws grocery-anchored property his team brokered, stating, “We wouldn’t have achieved the sale price or cap rate we did if it was not a triple-A grocer.”

“I wouldn’t say that’s a new trend, but it’s amplified for sure,” Edmison said. “Covid really highlighted the value of essentials. And again, it was good, and it just went to greater. If it was great, it went to excellent. It just amplified an existing trend, and it has not come off from that.”

Consequently, difficulties will persist for nonessential and independent retailers that likely will have to adapt their business models with more promotions and enhance their online presences to attract customers, Harrison added.

“I think it’s a tough slug for independent retail, and that’s not going to get any better, I think, ever,” Edmison said. “That’s just the world we live in.”

Supply-demand struggles will continue

A problem that brokers had hoped years ago would start to improve only continues to worsen: very little supply to meet an insatiable demand.

“We have numerous tenants looking for space that we can’t find,” Gorman said. “Not a problem I thought we’d have coming out of Covid. I anticipated more of a shake-up, but there’s still very high demand and limited supply.”

Virtually no large shopping centres are being built, and the primary source of new supply in urban centres is drying up: the podiums of new residential developments.

“Construction starts are way down, so I suspect we’re going to continue to see a pretty tight market,” Gorman said.

On the demand side, not only have there been significant increases to Canada’s population, but the pandemic illustrated a robustness of physical storefronts, pushing more retailers to believe it’s the best path forward. It solidified bricks-and-mortar retail as “the key component of a successful omnichannel strategy for retailers,” Harrison said.

“All you have to do is take a look at our occupancy over the past 18 months and it’s continuing to increase to the point that, last quarter, we hit 98% for our portfolio, which is a record occupancy,” he added.

Some new retail space continues to trickle onto the market as residential developments complete, but that may not be the case a few years down the line.

“We have an air bubble in the hose, so there’s still water coming out the other end, meaning condos are being completed that were put in the ground years ago,” Edmison said. “But there is nothing getting built. So in 2025, we will still see some completions, but I think in 2026, it’s almost nothing.”

The upside for investors: Constrained supply will continue to foster the healthy rent growth seen throughout 2024.